IMF Working Paper: e-money replacing cash currencies

Monetary Policy, Monetary Areas,
and Financial Development
with Electronic Money

The recent evolution of the technology for financial transactions poses interesting questions
for policymakers and financial institutions regarding the suitability of the current institutional
arrangements and the availability of instruments to guarantee financial stability, efficiency,
and effectiveness of monetary policy. The aim of this paper is to dispel some of the most
extreme predictions.

The disappearance of money, central banks made redundant, monetary policy made
irrelevant are not logical impossibilities, but extreme events. It is not impossible to envision a
world with these most extreme characteristics (King, 1999) and to describe its functioning in
the new setup, but how likely are these events to occur? The view that they will happen in the
foreseeable future cannot be shared. From an operational point of view, we need to ask
whether the actual institutional arrangements can respond properly to the recent wave of
financial infrastructure innovations and if their policy instruments are still viable.

Regulatory concerns are raised by internet banking, electronic finance (e-finance), and
e-money but are not addressed in these notes. Here the focus is primarily on the forces
sustaining the development of e-money and on the central bank ability to conduct monetary
policy in the presence of e-money.2

This paper argues that e-money, as a network good, could become an important form of
currency in the future. Such a development would influence the effectiveness and
implementation of monetary policy. If an increased use of e-money substantially limits
demand for central bank reserves, it would require changes in the operational target of the
central bank and a closer coordination of monetary and fiscal policies. The optimal size of
monetary unions could differ should e-money play a prominent role.

However, the current level of e-money use does not pose a threat to the stability of the
financial system, and central banks have the means to successfully implement the objectives
of monetary policy.

With respect to the current debate on the consequences of the introduction of e-money on the
implementation of monetary policy and in contrast with earlier work on this topic (Freedman,
2000; Friedman, 2000; Goodhart, 2000; and Woodford 2000), this paper argues that central
banks can lose control over monetary policy if the government does not run a responsible
fiscal policy. Central banks could react to this threat by introducing additional regulation or
by resizing the monetary areas which they ought to regulate, as we shall argue in later
sections.